Beware of second effects

Date posted: October 4, 2010

In economics as in life there can be unforeseen circumstances. Often we try to anticipate them but aren’t successful. One of these second effects was recently revealed for a program that has been very successful in assisting low-income households. N.C. State University extension economist Mike Walden explains.

“This program is the earned income tax credit. It is a program that actually gives cash to workers with families who are working at very low wages. So it comes out of taxpayer money, and it encourages people with those low wages to continue working and perhaps work more. In fact this program has been growing by leaps and bounds. It paid out $45 billion dollars in 2008 and increased the disposable income very dramatically of those low-income households. So it encourages them to work and, indeed, perhaps to work more.

“The problem is — and this was revealed in a new study — one of the secondary impacts is that if you increase the supply of anything, whether it be apples or workers or oranges, you increase the supply. The demand doesn’t change. You are going to have a reduction in that price. And in this case, the price is the wage rate.

“And so, indeed, a new study looking at the earned income tax credit has found that — yes, indeed — it has increased income to workers, those income workers; … it has encouraged them to work more. But as a consequence, it has lowered their wage rate. Now the reduction in wage rate has not been enough to wipe out the benefits of the earned income tax credit, but clearly it has been an unintended secondary impact.”

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